Unit 9: Income Distribution and Poverty as Market Failures

Anyone familiar with United States history knows that our country has experienced enormous economic growth. But income has not been distributed evenly, and many Americans have been left far behind. Remember in earlier discussions, it was mentioned that one of the roles of government to was try to ensure equity for its citizens. This section should help students understand the struggle for economic equity in our society.

In order to understand income distribution, one first has to understand how the government categorizes its information. The Census Bureau divides the population into quintiles. Each quintile represents 20% of the population, thus there are 5 quintiles. Your income in a year places you in a quintile. Bill Gates would find himself in the highest quintile (top 20%), someone living near the poverty line would find him/herself in the lowest quintile (bottom 20%). The middle class would find themselves in the middle three quintiles. How have Americans been doing? According to researcher Edward Wolff (pdf), only the top 5 percent of American families increased their percentage of the country’s total household net worth from 1983 to 2007. So unless you make $160,000 or more, your household value has decreased, percentage-wise, over the last 25 years. The table below shows the percentages of total income before taxes received by each fifth of American families in 1970 and 2014.

The statistics put out by the Census Bureau each year seem to indicate a pattern. Over the last few decades, the rich in the United States have gotten richer, and the poor have seen their incomes decline. Keep in mind that this is a positive economic statement. Why incomes gaps have widened is where normative statements come in. It is up to you as a student, to decide if the statistics on income distribution represent a social problem for our country. Use the link below to discover more about income inequality in the United States.

Income inequality in the United States decreased from the 1930’s to the 1970’s. Then starting in the 1980’s, income inequality has increased. Why? Economists cite many varied reasons for the gap in incomes. Age is one determinant. Older workers with more education and work experience generally make more money than younger workers. Another factor is differences in human capital. Talent and intelligence is not equally distributed amongst all members of society. Inheritance is another important factor. When individuals inherit cash, stocks, homes, or land, it makes it easier to generate income and to improve on one’s human capital. Finally, discrimination can influence income inequality. If particular groups (women, minority workers) are denied access to education, training, and jobs, then inequality will be passed on from generation to generation.

The factors listed above are constants that contribute to inequality in every generation. What are some of the factors that have contributed to the increase in inequality over the past few decades? They are:

1) Changes in tax law. Over the past few decades tax laws have been changed to reduce the amount of taxes that the wealthy pay. Many of these taxes are regressive in nature and have produced a tax shift from the wealthy to the poor. Over the past few decades, effective tax rates on US corporations and the richest 1% have fallen by about a third.

2) Decline in manufacturing jobs. Many in the middle and working classes worked at manufacturing jobs that paid well enough to support a family. Because of free market trade policies, many of these jobs have left to lower wage countries.

3) Decline in union jobs. As was mentioned above, union jobs typically pay more than non-union jobs. This is related to the decline in manufacturing jobs. Since 1970, the percentage of private sector workers in unions has fallen from 29% to 7%

4) Increase in illegal immigration. The past few decades has seen a spike in the number of illegal immigrants to the United States. This has had the affect of creating a surplus of workers, which depresses wages for middle and lower class workers.

5) A minimum wage that has not kept paced with inflation. Workers who collect a minimum wage have seen their purchasing power decline.

“We have to tolerate the inequality as a way to achieve greater prosperity and opportunity for all,” Brian Griffiths, who was a special adviser to former British Prime Minister Margaret Thatcher, said October 20, 2009 at a panel discussion at St. Paul’s Cathedral in London. The panel’s discussion topic was, “What is the place of morality in the marketplace?” The financial industry awarded itself a record $140 billion in total compensation for 2009. Goldman, Sachs all by itself passed out $23 billion in bonuses.

Income inequality in the US is no accident. It has conscious, deliberate origins, to be found in the policy initiatives of corporate America since the late 1970s, and the willingness of the politicians Corporate America elects in Congress, Presidents, and at State levels—Democrat and Republican alike—to implement those policy initiatives.

There’s the tax restructuring in favor of the rich and their businesses, free trade agreements and offshoring, the erosion of the real minimum wage, the dismantling of real pensions and employer contributions to healthcare, the shift from full time permanent jobs to part time and temp work, the destruction of unions and higher paying union jobs, the displacing of higher paid jobs with technology, substitution of credit for lack of wage growth, failure to invest in the US by corporate America, etc…That’s why jobs, real wages, and incomes for the vast majority of American households have stagnated at best, and declined in real terms for most.

Many sociologists and economists also point to structural inequality. Take for example the case of sea-front property in the French Riviera. As demand for these properties rises, perhaps from rich foreigners seeking a refuge for their funds, the value of sea frontage will be bid up. The current owners will get rents from their ownership of this fixed factor. Their wealth will go up and their ability to command purchasing power in the economy will rise correspondingly. But the actual physical input to production has not increased. All else constant, national output will not rise; there will only be a pure distributional effect.

Intergenerational transmission of inequality is more than simple inheritance of physical and financial wealth. Income inequality across parents, due to inequality of income from physical and financial capital on the one hand, and inequality due to inequality of human capital (skills and knowledge) on the other, is translated into inequality of financial and human capital of the next generation. Human capital inequality perpetuates itself through intergenerational transmission just as wealth inequality caused by financial wealth perpetuates itself.

Economists use the Lorenz Curve to graph income inequality. The Lorenz Curve graphs the cumulative percentage of income against the cumulative percentage of households. A straight line would indicate equality. The more a line is curved, the greater the income inequality. A sample Lorenz Curve is shown below.

We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can’t have both.” Louis D. Brandeis

Who owns financial assets such as stocks and bonds in corporations tells us who has a direct claim to the income generated by capital. Here is the distribution of financial asset holdings across the wealth distribution. This is from the 2010 Survey of Consumer Finances:

Poverty

Poverty is a relative concept. Someone who might be considered middle class in a developing country, might be considered poor in a developed nation. Yet, despite its relativity, poverty is a problem faced by all nations on earth. The information below should help understand the issues facing individuals and countries alike concerning poverty.

Poverty in the United States

As stated above, poverty is a relative concept. What represents a minimum living standard in one country, would not represent a minimum living standard in another. The United States tries to deal with the problem of relativity the best it can. The government, through the Department of Agriculture, has developed tool called the poverty line to measure poverty in the United States. The Department of Agriculture bases their estimates on the assumption that poor families spend one-third of their incomes on food. Each year it calculates the minimum food budget for a family of four for one week and then multiplies it by 52 for the weeks of the year, and then triples that figure to get the official poverty line. Click on the link below to access statistics from the US Census Bureau on the poverty guidelines.

Once the poverty line has been established, then the poverty rate can be found by dividing the number of poor people by the number of people in the country. The poverty rate declined during the 1960’s and 1970’s but went back up during the recessions of the 1980’s and early 1990’s. Since the economic crisis of 2008 began, poverty rates have increased to record numbers. Click on the link below for information about poverty in the United States.

Societies around the world have made attempts to deal with poverty, usually through a set of government programs. In the United States there have been a number of government programs created to deal with the problem of poverty. For someone to qualify for an antipoverty program, they must first past a means test. This is a requirement that a family’s income not exceed a certain level. Below is a brief description of some of the antipoverty programs.

Social Security. This a program geared mainly for the elderly or surviving family members. Workers may retire between the ages of 65 and 67 and receive full benefits, or at age 62 and receive partial benefits. Each worker must pay a payroll tax matched in equal terms by an employer. Most of the money is used on a “pay-as-you-go” basis to pay current benefit recipients. It also provides unemployment compensation and benefits to workers for on-the-job injuries.

Unemployment Compensation. This government program pays income for a short time period to workers who have recently become unemployed. This unemployment insurance is financed by a payroll tax on employers, which varies by state and according to the size of the firm’s payroll. Although the federal government largely collects the taxes and funds this program, it is administered by the states. Any insured workers who becomes unemployed, and did not just quit his or her job, can become eligible for benefit payments.

Temporary Assistance to Needy Families (TANF). Benefits for this program vary from state to state. The federal government, does however, restrict benefits for no longer than sixty months. Unwed teenage parents must stay in school and live at home, and people convicted of drug-related felonies are banned from receiving TANF or food stamp benefits. In addition, nonworking adults must participate in community service within two months of receiving benefits and must find work within two years.

Food Stamps. This government program began in 1964 and administered by state governments. It is one of the more heavily criticized components of the American welfare system. A food stamp recipient may exchange food stamps or coupons for needed goods, such as food. In 2011, the number of Americans receiving food stamps reached a record high of nearly 40 million people, or 1 in 8 Americans.

Medicaid. A government program that provides medical services to poor people under the age of 65 that have passed a means test. Generally, Medicaid goes to people who meet the means test for other public-assistance programs, such as TANF. It is financed by general tax revenues.

Housing Assistance. The federal government, through the Department of Housing and Urban Development (HUD), has a number of programs to provide affordable housing to poor people. Recipients pay less than the market value for apartments and therefore receive an in-kind transfer.

Economic Costs to Poverty

In economic terms, the cost to poverty are high. A study in 2007 found that the costs to the United States associated with poverty total about $500 billion per year. These costs stem from reduced productivity and economic output by the poor, increased criminal behavior, and poor health. If poverty were eliminated through jobs that pay a living wage, and adequate monetary assistance the entire society would prosper from the increased purchasing power and the larger tax base. Some of these economic costs are discussed in more detail below.

Crime: One of the economic consequences to high poverty rates is a corresponding high crime rate. Two social factors stand out in explaining the high crime rate in the United States: the high rate of poverty and the high rate of inequality. A high unemployment rate leads to higher rates of property crimes, homicides, and alcohol and drug abuse. Half of male prisoners were unemployed when arrested.

Family Problems: Poverty creates problems for families. Jobless people are three to four times less likely to marry than those with jobs. Two-thirds of teenagers who give birth come from poor or low income families. Poor couples are twice as likely to divorce as more affluent couples. Poor young parents who are raising young children have an elevated risk of using the most abusive forms of violence toward their children, as do poor single mothers.

Health Problems: What does it mean to a person’s health if they are poor? It means less money which means less nutritious food, less heat in winter, less fresh air in summer, less distance from sick people, less knowledge about illness or medicine, fewer doctor visits, fewer dental visits, less preventative care, and above all else, less first-quality medical attention when all these other deprivations take their toll and a poor person finds himself seriously ill. The economics costs to the poor of health care costs are many. In 2015, the Census Bureau reported that 29 million Americans did not have health insurance. Poor people without medical insurance can have expensive medical bills push them deeper into poverty. A recently published report states that families with lower incomes had higher rates of obesity. More than 33 percent of adults who earn less than $15,000 per year were obese, compared with 24.6 percent of those who earn at least $50,000 per year. Food options in poor neighborhoods are severely limited. Low-income workers may also have less time to cook their own meals, less money to join sports clubs, and less opportunities to exercise outside. Location of families plays a big role in their health because of the lack of good quality grocery stores in poor areas. If they do have access to grocery stores, the prices of healthy food soar way above fatty foods. And if they are poor they are going to get as much food as they can for their money and these cheap foods are loaded with fat, sugar, and empty calories. The combination of the burden of poverty linked to a poor diet leads to weight gain. The burden of poverty also causes a variety of mental health issues for the poor.

Problems in School: Children of families that are driven into poverty by recession are 15 percent less likely to finish high school and 20 percent less likely to finish college than the non-poor. According to the American Psychological Association, children who live in poverty experience a lack of quality nutrition and access to quality foods, which has a direct and significant impact on neurodevelopment. Parents living in poverty tend to have to work a greater amount of hours, and in many cases, more than one job. As a result, the parents of children in poverty cannot always be around to help continue the learning process at home, such as by helping with homework. Schools in the poorest communities tend to be the most underfunded, especially in the wake of recent budget cuts.

Poverty Around the World

Just as poverty in the United States is relative, so is poverty around the world. There are many definitions and debates about the number of poor in the world. One of the leading sources for information on poverty around the world is the World Bank. The World Bank distinguishes between two types of poverty.

Extreme Poverty. This category refers to people who live on an income of $1.25 per day. The World Bank estimates that in the year 2011, roughly 1 billion people were living in extreme poverty. People in this category cannot meet basic needs for survival. There is little or no access to education, health care, safe drinking water or sanitation. Most people in this category live in a rudimentary shelter with few possessions and are chronically hungry. A country as a whole is deemed to suffer from extreme poverty if the proportion of the population in extreme is at least 25 percent of the total population.

Relative Poverty. This category is defined as a household income level below a given proportion of average national income. Most of the poor in developed countries like the United States, fall into this category. These people are poor relative to the high income earners in their society. They have enough income to meet their daily needs, and perhaps a little extra for a few goods or services. But they still do not have access to quality health care, education, and other cultural goods that would allow them upward social mobility.

So what can be done about income inequality and poverty? There are many economists and other people in society who believe in the bumper sticker below:

Movies Relevant to This Unit Below are a list of movies that exhibit economic concepts learned in this unit.

1. Of Mice and Men. A mentally retarded giant and his level-headed guardian find work at a sadistic cowboy’s ranch during the Great Depression.

Books Relevant to This Unit Below are a list of books that exhibit sociological concepts learned in this unit.

1. The Spirit Level: Why Greater Equality Makes Societies Stronger (Bloomsbury Press, 2009), Richard Wilkinson and Kate Pickett have documented the numerous studies that correlate inequality with shorter life expectancies, increased disease and health problems, and even higher murder rates. These effects are attributed to the stress of “relative deprivation” — trying to survive in a community where economic, educational and health care disadvantages persist in an otherwise prosperous environment.

3. Capital in the Twenty-First Century by Thomas Piketty Piketty, arguably the world’s leading expert on income and wealth inequality, does more than document the growing concentration of income in the hands of a small economic elite. He also makes a powerful case that we’re on the way back to ‘patrimonial capitalism,’ in which the commanding heights of the economy are dominated not just by wealth, but also by inherited wealth, in which birth matters more than effort and talent.